Clear Eyed Capitalist

Archive for February, 2006

I’m starting to get some thought convergence on this subject. An early seed is my interest in socially responsible investing (SRI). At a first level, it started as mutual funds doing filtering, refusing to buy stocks of companies deemed socially irresponsible – however you choose to define it. In truth, I don’t believe that does anything and many other folks have already come to that view. What happens in the stock market is really only tangentially related to a company’s finances. They only make money off the stock when they make new offerings. Sure, having the stock do well lets them make acquisitions with it or compensate employees with it, but when you buy stock in a company, that money is not going to the company, it’s going to the last holder of the stock. So the theory of starving a company by reducing the tradability of its stock is a weak one, not to mention that it would take participation of a huge percentage of the market to actually create that impact.

SRI has more interestingly moved on to what I’ll call level 2, Shareholder Activism: the act of deliberately investing in ill-behaved companies and using that status as shareholder to try and influence their behavior. What’s going on in shareholder activism is a blog entry in itself that I want to write, so while I still feel some enthusiasm for that approach, I’ll skip here directly to my disappointment with it. Currently shareholders don’t actually have all that much power, particularly not small ones.

From there I move to, well, what really is this whole stock-market thing? What is it about the magic that lets you invest 300K in a company, go public and be worth a million? Is that a good thing? The markets encourage risk-taking and they provide liquidity. But it’s becoming a bit too derivative from actual economic activity when investment managers are running funds that trade based in psychological behavior models applied to the market. I’ve been getting interested in private equity – the process by which companies get early direct funding before they’re public. Basically you can get money two ways: 1) debt- where you borrow it and owe it back with a pre-determined return; or 2) equity – where someone makes an investment in your company and you owe it back with a uncertain return. With equity, they’re taking the risk with you, if it goes bust you all lose. Equity in this simple sense is collaborative.

But equity investing in practice is not at all collaborative. Equity investors in practice work to own you, and in our current capital-rules-all society, they can. The archetypical model is venture capital – groups of investors whose goal is to make big money, usually on a short time frame like 5 years. Because markets and business change, the short time frame is a way for them to control their own risk, by getting theirs while it’s still a high-probability thing. VCs follow a “blockbuster” model that is high-risk but theoretically high-reward. To make it work, you only look at companies that have a possibility of a 35+ percent return in the short term. You invest in 8 or 9, knowing that odds are only one or two will actually hit, but those that do have the potential to make enough money to cover your losses on the others. It’s very much a gambling business model. However, VCs don’t just gamble, they work to minimize their risk by taking controlling stakes in their investments. In any company there are hundreds of decision making opportunities that define what kind of company it will be. The VC is there to ensure that making the most money possible is the highest priority. This is about maximizing, not satisficing.

Companies making profit maximization their highest priority are in a bind now when it comes to making good decisions about their other stakeholders (employees, suppliers, local communities) or their environment. VCs don’t have a standard by which they can say something is “good enough”, the standard they’re evaluated by is competition with everyone else, and the measurable standard they’re all competing on is profit dollars.

By this very system of funding, we create and build companies that are unsustainable. By that I mean they prioritize short-term profits over their long-term impact on stakeholders (including shareholders) and the environment. This early investment cycle ends when the company goes public or is bought out, thus cashing-out the VC investment but by then the groundwork is laid. Going public is a continuation of this process. Who owns you now? Shareholders officially. But it’s not the average folks that get listened to, it’s the folks with sizable holdings – brokerage houses and hedge funds. Now the company’s leash is held by investment analysts who again evaluate them purely by financial standards and who more and more look only at the short term. I went to a CEO panel talk at Seattle U. on corporate turnarounds. One of the CEOs talked about meeting with analysts after getting his company on a firm footing; in an entire season of meetings only once did someone ask him about next year. Everyone else was focused on next quarter. He said that the trouble now is that they’re all speculators rather than real investors.

The backlash against Wal-Mart and the attention paid to the Costco-analyst incident show that a sense that we need to make some fundamental changes is building. There is something wrong with the role the market is playing in our economy. This morning a friend of mine pointed me to the blog of billionaire Mark Cuban, where I found a good capture of the difference between investors & speculators.
It’s interesting that he categorizes investment as win-win and speculation as zero-sum (win-lose). I once had an investment manager suggest to me that the market is a zero-sum game. What did his company do? Arbitrage. One of the replies to Mark’s blog captures it perfectly. “Scott” writes: “It’s unfortunate that raising capital for a startup is directly related to the exit strategy.” I’m not sure I’m impressed with Mark’s tax incentive solution, but he’s onto the right problem.

So what are the solutions? Well, I think we’re still in a phase of convincing enough folks that we have a problem, but experimentation is already starting on the cutting edge. Corporation 2020 is an organization formed to bring people together to think about problems and solutions. One of the founders is Marjorie Kelly, editor of Business Ethics magazine and author of The Divine Right of Capital.

I’m investing in a new fund that is about investment, not speculation. It will buy and hold socially responsible companies while they grow. It’s called Upstream 21. Written into the corporate charter is the axiom that it is responsible to all stakeholders: shareholders are not more equal. Unfortunately, to invest you need to be an “accredited” (or “sophisticated”) investor – yet another layer to this onion: many folks are restricted by SEC regulations, designed to protect them, from doing the kind of direct company investment that is about building your own community. However, I think this too may be exaggerated – if you’re not planning to get big or raise big money (max 2 million), this isn’t quite as prohibitive as it seems. If small companies can get help with financial reporting instead of hoping for “dumb money” that will invest and go away, I think this can be overcome. Certainly that would be less painful than selling your soul to the profit counters.

I’m headed off to school to fill my brain once again to overflowing. Before it’s too late, I wanted to capture some inspiration from the Executive-in-Residence from our January session, a retired army Colonel Mike Kendall. It’s tempting to think it’s a bit odd for a green fuzzy business school to bring in an Army Colonel to tell us how to do business, but the truth is the military is first in socially responsible managment; the army truly manages everything about the lives of their employees down to the spouse and kids.

It’s also tempting to assume the Army doesn’t need to be too sophisticated about managment – they give orders, right? A former Navy friend of mine quickly dismisses that. He assures me that if the people under your command don’t approve of your managment style, they have ways of making you suffer. So below I’ve created some quick management gems inspired by Colonel Kendall:

1) Metrics for Managers – what’s your sleep plan? People crack when they’re not taking care of themselves, one responsibility for lower level folks is to have a sleep plan for themselves to make sure they’re getting their rack time. How many corporate employees acknowlege this importance?

2) Shit Detail is for Leaders – literally. Higher level managers motivate and earn respect when they are willing to participate in even the worst detail. They also get the best insight into the challenges and operations of their organization by taking hands-on looks at all levels.

3) Prime to Promote – in the military you don’t recruit your next General by stealing him from the UK or Bolivia, you’ve got to grow your own. You also never know in the field where command may have to fall. Every member of an operation must be trained to know and understand the mission. People at all levels need opportunities to practice leadership.

4) Own it and Fix it – create a culture of acknowleging mistakes. If you did proper training, then mistakes tend to have three sources: a) poor self-dicipline on the part of an individual; b) poor supervisor communication; c) an institutional problem or procedural failure.

In economics our discussion has turned to a truly basic question: what do we really need? Instead of focusing on how we could imagine wanting more than we have, and therefore there is scarcity, let’s examine that basic question. Is there really scarcity? Do we really NEED more goods?

From our book what we need for Well Being
– food shelter etc
– respect of others
– a sense of belonging
– free time & energy to enjoy life beyond work
– ability to make choices about things that affect us
– enjoyment of the natural environment

This goes with a definition of poverty offered by Sen: the ability to appear in a community of one’s peers without shame. In the US, we acquire and focus on goods so much that one can feel impoverished without a TV or a telephone. Perhaps instead of trying to produce so many goods that TVs trickle-down to everyone, we should re-invigorate bowling leagues.

This thinking gets a boost from Ecological Economics – a view of economics that recognizes that the economy is a subset of activity within the larger ecological system of our planet. All of our economic inputs and outputs ultimately connect to that larger system; a system with actual physical limits. We can use our water supply to dilute chemical solutions we’ve made by mining things out of the ground, but dilution can be the solution to pollution (something I learned in college chemistry) only for so long before the concentrations are no longer ignorable. Most likely that will be long after concentrations are having an effect. There’s a system called Ecological Footprint Analysis where researchers add up the amount of arable land needed to support our food consumption, fuel consumption and re-purify our air and water. In the US calculations show we need about 10 hectares of land per person to support our lifestyle. Globally there are about 1.8 per person available.

The Natural Step is a sustainability framework that focuses on core physics principles such as these as a guideline for how we need to run our industries and businesses. The 4 core principles are
1) – from the first law of thermodynamics – matter is neither created nor destroyed. When we incinerate something, it doesn’t just “go away”, it’s transformed into parts that go into our atmosphere, and residue that remains. How does that stuff come back out of the atmosphere? We need to make sure it does, otherwise we are on a path to permanently change our ecosystem with no guarantee that it will continue to support us.
2) the 2nd law of thermodynamics – entropy. Matter and energy continually disperse. So let’s just acknowlege that genetically modified crops can’t be controlled (we can master the laws of physics, can we?) and stop being amazed that chemical compounds from our Teflon pans end up in our bloodstreams. It’s inevitable, so perhaps we should make change up front in how we do things.
3) Recognize the value of ecosystem services to our economy and take steps to protect them. Minimize waste, maximize reuse of resources.
4) Use resources fairly and effectively. When people are in survival mode they don’t take steps to protect resources for later generations. It wasn’t so long ago that the wilderness was a scary place to be tamed, so we chopped down forests and killed off wildlife populations. Now we aren’t so desperate ourselves and we can do better. By ensuring everyone is doing better, we ensure that all resources can be treated respectfully.

Another refinement on the perspective of how we can interact with our multi-thousand-year tested ecological system is to learn from it. Recognize how every output is an input to another process. We like to think we’ve started that with recycling, but in truth most “recycling” today is really downcycling. Soda bottles don’t become soda bottles again, they become park benches. Park benches can become…? We’ve put that off. In a true system, there would be indefinite circulation of materials, just like there is for carbon, nitrogen and water in the ecosystem. The trouble is, we mine things like copper and we create mass quantities of things like phosphorous and then we discard them into the ecosystem where they gum up the works. We need to only discard into the ecosystem what belongs there and can be appropriately handled, and then we need to create our own systems: a technical metabolism, that can cycle non-biodegradable materials or quantities larger than what the natural system can handle.

For this to work, we need to take the future of our products into account at their creation. Wool-polyester might be cheaper to sell, but it’s also non-recyclable – the wool and polyester are too hard to separate. Computers and many electronics have been documented as having as many as 19 different resins in a single box, making them impossible to recycle. Recycling is better than pollution control, but designing for a full product lifecycle is the future, embodied in such books as Cradle To Cradle (see their non-profit at GreenBlue.org) and in such legislation as state-level producer responsibility laws for electronic waste.